The global economy is experiencing disinflation and resilient growth, with central banks likely to ease monetary policy in the near term. Inflation continues to decline across developed and emerging market economies, though unevenly. Labor markets are moderating, with job creation slowing and wage pressures easing. Consumer spending remains resilient but shows signs of weakening. Real yields remain high, exerting downward pressure on economic growth. In the current economic environment, the Macro Opportunities strategy favors a long duration bias, especially in US Treasuries (USTs), while selectively maintaining positions in emerging markets and reducing exposure to investment-grade and high-yield credit due to tight valuations. Here are some key takeaways.

Global Outlook

• Global growth is expected to slow, particularly in the eurozone, with real yields remaining high and exerting downward pressure on economic activity.
• US economic growth is projected to moderate, with expectations for 2.0%-2.5% in 2025.
• The US dollar is expected to gradually weaken as the Federal Reserve (Fed) starts its rate-cutting cycle, providing a tailwind for emerging market (EM) currencies.
• EMs are seen as decoupling from China’s economic influence, with countries like Mexico, Brazil, India and Indonesia benefiting from increased foreign investment.
• Corporate credit fundamentals remain strong, but valuations are tight with carry expected to drive returns in near term and risks for spreads to widen from current levels.

Inflation

• Globally, inflation is declining across advanced economies, though at different rates and unevenly across CPI baskets.
• US inflation is on a declining trend overall, though the core personal consumption expenditures (PCE) index saw a temporary jump in 1Q24 due to one-off factors like auto insurance and rents.
• The Fed expects inflation to continue moderating toward their target and is waiting for more data confirming declining inflation and jobs.
• The UK is seeing sticky inflation, particularly in services and wages, despite headline CPI nearing the 2% target.
• Japan is experiencing wage pressures that may prompt the Bank of Japan (BoJ) to further hike rates in the near term.
• China is experiencing mild deflation, which is helping to export disinflation to other large economies.

Central Bank Policy

• Central banks, including the European Central Bank and Bank of England (BoE), are anticipated to ease monetary policy the near term with the Fed expected to begin easing in September.
• The BoE is in a tricky situation with high services inflation, but is still expected to start cutting rates, potentially faster than market expectations.
• Real yields remain high, exerting downward pressure on economic growth. This is seen as a reason for central banks to start easing monetary policy later this year.
• The BoJ is an outlier, with wage pressures potentially prompting another 10-basis-point rate hike in the next couple of meetings.
• EM central banks had to pause their rate cutting cycles earlier this year due to inflation concerns, but are expected to resume easing once major central banks begin cutting rates.

Investment Themes

• The Macro Opportunities strategy is positioned to take advantage of global disinflation and prospects for central bank easing. As a result, the portfolio maintains a bias to be long duration and holds select EM currencies, which we believe will benefit in the current environment.
• The strategy provides concentrated exposure to Western Asset’s key investment themes. The active trading approach of macro strategies can provide stability during periods of market stress. Historically, the strategy has had low correlation to equities and traditional fixed-income, making it appealing to investors looking for diversification.
• Regarding EM countries, while there could be some negative impacts from US election outcomes, we expect EM overall to hold up relatively well due to factors like foreign direct investment flows.
• To hedge against potential risks, the portfolio maintains long-duration positions, particularly in USTs, as well as short positions in currencies like the euro, British pound and Chinese renminbi.
• We’re reducing exposure to both investment-grade and high-yield credit in the strategy through selective trimming of certain names and CDX positions, in an effort to rebalance risk and capitalize on recent market movements, while maintaining significant positions in other areas like EM and tactical positions in agency MBS.
• The strategy’s current yield may provide a cushion against adverse scenarios.

Audience Q&A

• Regarding the US election, both Trump and Harris presidencies would likely maintain high budget deficits but differ in their approach to taxes and spending. Trump may renew tax cuts while Harris could increase infrastructure spending.
• A Trump presidency might impose higher tariffs on Chinese imports, potentially keeping inflation higher for longer, but the overall impact on the US economy and inflation may be limited.
• EM countries are expected to demonstrate greater resilience to the US election outcome compared to previous cycles, largely due to their reduced dependence on China. While a Trump presidency could pose challenges for some nations like Mexico, the overall outlook for EM economies remains relatively stable regardless of the election result.